Commercial Property Insurance

Commercial property insurance is a highly technical area and needs to be grasped by freehold owners, landlords and tenants and occupiers alike.

For freehold owners, it is just a question of making sure that the right risks are covered. These include the usual commercial risks but also third party liability. If the premises are in inner city area terrorism insurance should also be included. You need to get the advice of a surveyor or valuer to ensure that the reinstatement value is accurate.

For leasehold properties, both landlord and tenants need to get their heads around a whole host of issues and this is what this article focuses on. The insurance provisions in a typical lease are found about two-thirds of the way through the lease just after the Landlord's covenants. Most leases would oblige the Landlord to insurance the premises recouping the cost of the premiums from the tenant or tenants in a multi-let building.

The Landlord wants to insure because it means the landlord can ensure that his investment is protected. It is too risky to allow the tenant to ensure and then find out later that the tenant has either not been insuring or has insured for less than the reinstatement value.

The Landlord covenants to insure the building in the full reinstatement value against the usual commercial risks. Reinstatement value is usually determined by annual insurance valuations. It is important that the Landlord uses a surveyor for this because if the insurance proceeds are insufficient to reinstate the building or premises, most leases oblige the landlord to make any shortfall out of the landlord's own monies.

The insured risks would normally include loss or damage by fire, explosion, flood, tempest, storm, lightning, impact from aircraft and vehicles, bursting of tanks. If you are a tenant you should also get subsidence landslip and heave added to the insured risks. These risks are usually covered for most commercial policies but leases for some reason do not include these risks as standard in the definition of "insured risks".

The landlord will also insure against loss of rent. The period varies from 2 to 3 years and is supposed to cover the time it would take to fully reinstate the building in the event of total destruction or damage. The insurance provisions will also include a provision providing that in the event of damage or destruction to the building such that the building cannot be occupied or used by the tenant, then the rent is suspended (but not usually the service charge) for the loss of rent insurance period. The ideal for a tenant here would be that the rent would be suspended until the building is reinstated such that it is fit for occupation and use by the tenant.

The lease should contain an obligation on the landlord to lay out all insurance monies received in reinstating the building. You would not want the landlord pocketing the money and terminating the lease. There are often provisos to this reinstatement obligation stating that if the landlord is unable to reinstate for whatever reason then either party can terminate the lease. This is usually after a lengthy period of time say 2 to 3 years although a tenant would probably want this right of termination to kick in as soon as becomes apparent that the landlord cannot reinstate the building.

The tenant's repairing obligation in relation to the premises would normally state that damage by insured risks are excepted from the tenant's obligation so if the premises is damaged by an insured risk then the tenant is relieved of the obligation to repair the premises. However, this wording is usually qualified to state that if the building was damaged or destroyed due to the tenant's fault then this does not apply and the tenant would then be obliged to reinstate out of its own monies. This could be catastrophic for a tenant who would not be able to claim on any insurance policy of its own because the tenant would not usually double insure the building it is occupying. Some tenant's solicitors try to amend this so that the tenant is only liable to repair the uninsured damage to the extent that the damage was the fault of the tenant so that if the landlord is partially responsible, the landlord will bear a proportion of the liability and so some of the insurance proceeds will be available.

What happens if the lease is terminated because it is not possible to reinstate the building (say the landlord could not obtain planning permission)? Who gets the insurance proceeds? Most leases would provide that the landlord gets to keep all of the insurance proceeds but it would be fairer if the insurance proceeds are divided up in accordance with the value of the landlord and tenant's interest in the building. Whilst more fair to the tenant, I pity the valuer/surveyor who has to value that without any guidelines. Does the tenant have an interest in a lease under which it pays a full open market rental? Surely, this is classified as a liability rather than an asset?

Another question which a tenant should focus on is if the rent is suspended whilst the building is destroyed or damaged what about where the tenant has just paid 3 months in advance. Should the landlord be allowed to sit on what could be a substantial sum of money whilst everyone waits for the building to be reinstated? A small amendment to the lease can provide that in the event of the rent being suspended after damage or destruction, then any monies paid in advance by the landlord should be refunded. The obligation to pay rent in advance will kick in again once the rent suspension is ended.

Most leases provide that the landlord should insure the building with reputable insurers. In these rocky times with great giants like AIG teetering on the brink of collapse what constitutes a reputable insurer is not so straightforward an issue as it used to be.